Answer a few questions to see if you are correctly and efficiently handling your Indirect Rates.
In Part 1 of this blog, we discussed how to set up your accounting system to support building an allocation methodology for your indirect cost. We walked you through the calculations for computing fringe, overhead, and G&A indirect rates. In Part 2 of this blog, we'll explain how indirect rates are applied to calculate the fully burdened costs and, why successfully managing cost-type contracts requires examining fully burdened costs. We make the case that job cost reports should be generated using bid, target, actual, and forecast indirect rates.
Competitive indirect rates are key factors in winning government grants and contracts. Your company's indirect rates provide crucial insight into how well your company manages its costs - a very important detail when you're doing business with the government. Competitive indirect rates tell the government that your company has a low financial performance risk. As we discussed in Part 1, well-run government contractors prepare an annual operating budget and use it to develop target indirect rates. Establishing target rates provide a way to monitor your actual financial performance against what was planned. If you have a cost-type grant or contract you will be required to prepare and submit a forward pricing proposal to the government which includes your annual budget as well as justification for your billing rates. This information will be used to create provisional rates that will be used when generating customer invoices. The government will use this data to monitor your performance on any cost contract.
Provisional/Target indirect rates are used when building the project plan cost buildups. When bidding on cost-type contracts, you'll need to submit supporting documentation showing how these rates were calculated. If you don't have cost-type contracts and no approved provisional billing rates, you are allowed to adjust the indirect rates you use when bidding based on your view of your planned budget or how your rates might change over time.
To illustrate how the cost recovery rate gets applied let's examine labor costs. When your employees complete their timesheets, they are recording their time spent working on each grant or contract. They use a charge code to record their time spent on each activity. When the timesheet period ends, the timesheets are processed, and a labor distribution report is produced. Each hour of direct labor must be burdened so that it includes the indirect cost based on the indirect cost recovery rate. A DCAA-compliant accounting system will maintain the detailed segregated cost breakdown in a separate sub-ledger called the project ledger. The project cost maintained in the general ledger must reconcile with the project ledger. The project ledger is used to produce customer invoices and the incurred cost submission.
The labor distribution provides a summary of all the hours as well as the labor cost for each employee. This information is used to update the project ledger (PL) that is used to produce job cost reports. The labor distribution is also used to create journal entries (labor and fringe benefit entries) used to record the cost of the labor in the general ledger (GL).
The same process is used to record transactions involving expenses and material purchased. Using the information contained in the charge code, the project accounting system can assign the cost to the correct GL account.
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Jim Garrett - Instructional Systems Designer |
Annual Salary: $100,000 |
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| Indirect Rates: Fringe Rate = 32% Overhead Rate = 25% G&A Rate = 12% Fee = 10% | ||||
| Cost Category | Segregated Cost Calculation | Target | Actual | Variance |
|
Direct Labor (DL) |
= Annual Salary / 2080 |
$ 48.08 |
$ 48.08 |
$ 0.00 |
|
Fringe |
= DL * Fringe Rate |
$ 15.38 |
$ 19.23 |
$ (3.84) |
|
Overhead |
= (DL + Fringe) * Overhead Rate |
$ 15.97 |
$ 21.54 |
$ (5.67) |
|
G&A |
= (DL + Fringe + Overhead) * G&A Rate |
$ 9.52 |
$ 13.33 |
$ (3.81) |
|
Fee |
= (DL + Fringe + Overhead+ G&A) * Fee |
$ 8.88 |
$ 10.22 |
$ (1.33) |
|
Fully Burdened |
= (DL + Fringe + Overhead + G&A + Fee) |
$ 97.73 |
$ 112.39 |
$ (14.66) |
|
Billing Rate |
$ 97.73 |
$ 112.00 |
$ (14.66) |
|
The table above provides an example of how to calculate the direct cost, segregated cost, and fee. The total represents the fully burdened costs, consisting of direct costs with all the indirect rates applied. In this example, we've provided typical fringe, overhead, and G&A indirect rates. For an example involving expenses, only G&A and M&H would be applied, if those markups were allowed by the contract. Your indirect rates must be calculated using your accounting system using the actual cost incurred. If you are bidding on a cost-reimbursable contract, your company will be required to submit supporting justification to the government with its cost proposal to show how these rates were determined. These are called your provisional/target indirect rates and must be approved by the government. An integrated project accounting system uses the approved provisional/target rates to calculate the fully burdened cost. Provisional/target rates are also used in generating the customer invoice for cost-reimbursable contracts.
An integrated project accounting system manages the details of computing indirect rates and calculating the fully burdened project costs. Fully burdened cost is computed using four different indirect rate scenarios:
Target and Bid Rates are static and don't change that often. Normally, target account balances and rates are set when the annual operating budget is finalized. Bid rates are set when developing the pricing for a specific contract.
Actual and Forecast Rates are dynamic and change after each accounting period is closed. They are computed based on the actual balance in the project ledger which is updated after transactions are recorded and posted. Forecast rates provide the ability to do "what-if" analysis, as they can be updated in response to unplanned events, such as losing or winning a new contract.
As we discussed in Part 1, most commercially available accounting systems don't support the ability to calculate indirect rates and therefore cannot generate job cost reports using fully burdened cost. Most integrated project accounting systems designed to support government accounting requirements support viewing project costs using only actual and target indirect rates. Only OneLynk, from AtWork Systems, supports the ability to generate project cost reports using bid, target, actual, and forecast rates.
Government contractors spend many hours managing planned versus actual costs. The accounting staff is responsible for preparing the annual budget, recording business transactions, computing indirect rates, and using them to compare actual financial performance against the budget. The project management staff is responsible for managing projects and tracking each project's financial performance. The PM must constantly monitor the project performance by reviewing job cost reports and comparing planned versus actual budgets. Just looking at the target versus the actual cost is not sufficient to obtain the full picture of the project's performance. The table below summarizes how each indirect rate set provides the details needed.
|
Indirect Rate Type |
How it helps when managing contracts/projects |
|
Target |
Based on the annual operating budget you'll develop provisional/target indirect rates. These rates are used to create billing rates that will be used when generating customer invoices. You need to monitor your actual performance using your actuals rates against the targets based on the operating budget to determine if your financial performance is on track. If there is a significant variance, then you'll need to put in place the appropriate corrective actions, such as lowering direct labor costs or other indirect expenses to reduce the variance. |
|
Bid |
If you have approved target rates, you should use them when bidding/pricing new grants or contracts. If you are competing for a new grant or contract and you're aware that your financial picture has or will change significantly i.e., you have won or lost contracts, after you established your target indirect rates, then you may want to bid lower rates to improve your competitiveness. If the lower rates allow you to win the contract, then you must produce job cost reports measuring how well you are performing against the bid rate. |
|
Actual |
As you record business transactions you will be processing direct, indirect, and unallowable costs. The actual cost associated with these transactions will be used to periodically calculate your actual indirect rates, usually monthly, when closing the accounting period. The actual rates help you monitor your company's overall financial performance. |
|
Forecast |
Like most things in life, things don't always go according to plan. If you run a small business losing or winning contracts can have a significant impact on your direct and indirect costs. Losing a contract can reduce your direct labor which can increase all your indirect rates. This will also increase your fully burdened cost. Winning contracts have the opposite effect as it increases your base and lowers your rates. Forecasting budget changes allows you to re-plan the impact of losing/winning contracts so you will be able to quickly analyze the impact of these changes and can put in place the appropriate corrective action. |
When transactions, such as timesheets, expense reports, and vendor invoices are approved, the indirect rates are applied to compute the fully burdened cost. The segregated cost data consisting of the direct labor, fringe, overhead, G&A, and any applicable M&H cost is stored in Project Ledger (PL). The integrated project accounting system uses the PL data to provide project status reports (PSRs) using bid, target, actual, and forecast indirect rates.
These reports allow you to conduct variance analysis to ensure that your planned cost and actual cost are in sync. If they are not, a corrective action plan must be put in place to address potential cost overruns. In the table below, we provide a brief explanation of how comparing actual job costs using target, bid and forecast can provide additional insight to help you establish better internal cost management practices.
|
Variance Analysis |
How it helps when managing contracts/projects |
|
Target vs Actual |
Comparing your project cost based on what your target is versus what your actual cost has been. When the target cost is compared to the actual cost, you'll are provided a measure of how well the company is meeting its annual operating budget. If there is a significant variance between the target versus the actual this will need to be analyzed and corrective action will need to be put in place. Failure to do so can have significant consequences on any of your cost-type contracts. Under-running actual rates could mean that you must refund money to the government during an audit or close-out. Over-running actual rates means that your customer may question your ability to put in place good financial controls. They may also decline to cover the cost of any overruns. |
|
Bid vs Actual |
When developing a proposal for a new contract, there are a host of reasons, you might submit billing rates that are lower than your approved target indirect rates. Comparing your project cost based on what was bid versus what your actual costs have been allows you to determine if you are managing project cost based on what was bid. Under-running bid will mean that your projects will be more profitable and that's good. Over-running bid means that your projects will be less profitable than you planned, and you will need to analyze the variance and put appropriate corrective actions in place. |
|
Forecast vs Actual |
Because things don't always go according to plan, you will periodically want to revise your operating budget using a new forecast and re-calculate your indirect rates. The forecast allows you to perform "what-if" analysis comparing your actual rates to the new forecast rates. Under-running forecast will mean that your project costs are doing better than your forecast and that's good. Over-running forecast means that your project costs are exceeding what was forecasted and you will need to analyze the variance and put appropriate corrective actions in place. |
AtWork Systems' OneLynk platform, provides an integrated suite of tools you'll need to address the accounting and project management requirements for managing government grants and contracts. As the GovCon industry's most DCAA compliant ERP system, OneLynk, was built from the ground up to support project accounting and the ICE Model. OneLynk provides information that contractors need to prepare accurate and timely job cost reports as well as the incurred cost submissions (ICS). The integrated project and general ledger generate the list of required schedules for the ICS using data directly from the accounting system. Both the general ledger and project ledger have been optimized to support the project accounting and the ICS submission. To learn more about AtWork Systems, visit our website at: www.atworksys.com
A more complete explanation of the accounting requirements can be found at "What is the SF 1408".
A more complete description of AtWork Systems' project accounting system, OneLynk can be found at OneLynk's Contract & Project Management.